Trade Finance and the Financial Crisis

Submitted by Otaviano Canuto
On Wed, 09/28/2011

As the 2008-9 financial crisis spread from its epicenter in the United States to the rest of the world, policy makers found themselves in uncharted waters. The effects of the global contraction were so severe that the world experienced the largest drop in global trade volumes since World War II, with world trade of goods falling by 23 percent in 2009. But was a lack of trade finance solely to blame for the trade collapse, or was it more a symptom of reduced global demand caused by spillovers of the crisis to the real economy?

In the most recent Economic Premise[1], World Bank economists Jean-Pierre Chauffour and Mariem Malouche analyze whether the freeze in the financial markets caused this unprecedented drop in global trade. In “Trade Finance during the 2008-9 Trade Collapse: Key Takeaways[2],” the authors provide insights into the role of trade finance during the recent crisis, as well as the data and knowledge gaps of trade finance and government interventions during the financial crisis.

Interestingly, evidence suggests that the availability of trade finance was different in developed and developing countries during the crises. In advanced and emerging economies, bank-intermediated trade finance largely held up, even as it came under several sources of strain. However, this was not the case in some developing countries. In 2009 and 2010, the World Bank conducted a firm and Bank survey in 14 developing countries across five regions, which found that the global financial crisis constrained trade finance in developing countries for exporters and importers alike. In particular, the survey showed that small and medium firms (SMEs) were more affected than larger firms because of their weak capital bases and bargaining power, and that banks in developing countries became more risk-averse in light of the drastic reduction in global liquidity and a decline in the number of intermediary players.

With respect to the 2008 trade collapse, the authors argue that trade finance was not the main driver; rather, trade volumes dropped mostly as a result of the spillover of the financial crisis to the real economy, including through lower activity and destocking. Nevertheless, the most recent financial crisis provides a myriad of lessons learned in terms of trade finance. As the authors argue, they range from the fact that gaps in trade finance data impede policy formulation, to the understanding that not all forms of trade finance are equally resilient in times of crisis.

Accordingly, for policy makers and development practitioners interested in gaining insights into the financial crisis, as well as the role of trade finance, I recommend taking a close look at the key takeaways presented in the latest Economic Premise. Only by learning from the lessons of the most recent financial crisis will we be able to prevent (and mitigate) the next.